The Economy Can’t be Fixed without it

Most Americans have never heard of the Foreign Investment Tax Credit and few politicians have chosen to educate them on this issue. Yet in this election year as more and more American jobs continue to be exported at an alarming rate, with all of the attendant economic and social dislocation this entails, it is high time that Americans learn about the economic incentives that the tax code currently gives multinational corporations to do exactly that.

On the website AmericanProgress.org, a small break with the long tradition of silence on the part of politicians on this issue occurred this year when James Kvaal, a Harvard Law School student and a senior policy advisor to former Democratic candidate for President, John Edwards, published an examination of the issue. The tax code, Kvaal states, encourages multinationals to invest outside the United States paying little or no US taxes on foreign profits, even when these profits are derived from trade with the United States. Shockingly, in some cases these tax credits are larger than the US tax due, creating a negative tax situation, in which the taxpayer is actually forced to pay them for their offshore investments.

According to the Tax Code, the Foreign Investment Tax Credit can include but is not limited to credits for foreign taxes paid as well as deferment of US taxes on foreign profits. This effectively shields US business activity from US taxation, using aggressive accounting to shift income from the US to low tax countries such as the Cayman Islands, which erodes the tax base, as well as all of the conventional tax credits including depreciation and other investment that is typically written off by businesses in the US. It is clear that there are significant tax advantages for multinationals to relocate their operations overseas and not all of them have to do with the cost of American wages and other costs of doing business associated with domestic business activities.

Worse, it does not take a great deal of imagination to see that bribes to corrupt foreign officials can be written off as consulting fees, or that in an atmosphere where corruption is rampant, as certainly is the case in much of the third world, that expenses, salaries, etc. could be padded to the hilt if not blatantly falsified, since foreigners do not need to report their incomes to the IRS. It also seems likely that the IRS has no effective way of auditing expenses claimed by multinationals overseas. Further, the complexity of tax regulations make IRS oversight of the use of the credit problematic.

According to the April 30, 2007 edition of Practical US/International Tax Strategies. the bi-monthly report of World Trade Executive, Inc. the IRS has been attempting to rein in the use of foreign investment tax credits created by a complex scheme in which involves the multinational borrowing money from a foreign bank. Rather than directly borrowing from the bank, however, the multinational uses a three step scheme that allows it to borrow more cheaply when the tax results are taken into account. The multinational creates a special purpose subsidiary or SPV which it then turns around and sells to the bank for the amount it wants to borrow and agrees to buy back the SPV in five years as a purchase price to buy back the SPV. Immediately before selling the SPV to the bank, the multinational makes a capital contribution to the SPV which the SPV in turn lends to a US based subsidiary of the multinational. Both the foreign bank and the multinational are credited for taxes paid by the SPV and the multinational receives foreign investment tax credits based on a transaction, which albeit complex might well not actually change the financial position of the company at all. Practical US/International Tax Strategies states that while proposed new IRS regulations would label such payment of foreign taxes as voluntary and therefore not directly eligible for the foreign investment tax credit, the practical effect will be to invite more planning to circumvent the new rules.

In the March 20, 2008 issue of USA Today, the headline asks Does Tax Code Send US Jobs Offshore? The answer appears to be a strong yes. The article quotes Martin Sullivan, a contributing editor of Tax Notes as stating unequivocally that this is the case. Exxon Mobil has been able to shelter $56 billion in foreign profits, Pfizer about $60 billion and General Electric about $62 billion in foreign profits simply by simply parking them offshore. General Electric refers to the offshore profits as undistributed earnings. The article goes on to report that there have been attempts in the past to reform the tax credit going back to the first year of the Kennedy Administration. In April of 1961 JFK asked Congress to rewrite laws that favored investment abroad compared with investment in our own economy. As reported in the Congressional Record, the most serious challenge was the Burke-Hartke bill of 1973, which would have eliminated the tax credit entirely. It was defeated by a strong lobbying effort on behalf of the multinationals and the opposition of the Nixon Administration.

While, Kvaal proposes a very modest partial exemption system which would not be aimed at nations such as France, Japan, etc. where income is taxed at a comparable rate to the US, but would fully tax income from low tax nations such as the Caymans and others. Clearly most Americans and the media could be forgiven for not wanting to concern themselves with issues of tweaking the tax code. Clearly only the demand to end once and for the Foreign Investment Tax Credit would draw sufficient attention to the problem to interest the masses and therefore the media. The evidence that the tax code has had a great hand in encouraging the export of American industry and jobs is overwhelming. Reports from the Congressional Budget Office, Treasury Department and National Tax Journal all conclude that there is. extensive quantative evidence that international taxation influences the amount and location of direct foreign investment. Foreign tax havens and low tax nations are, they conclude a growing threat not only to the nation’s tax base but to its overall economic viability.

The question then becomes why no mainstream politician has chosen to really educate the American people about the Foreign Investment Tax Credit. The answer, undoubtedly has a great deal to do with money, as does just about everything. No doubt an end to the foreign investment tax credit would bring screams from the Chambers of Commerce, multinational corporations into every business from oil to clothing, which is to say just about every large US corporation. Yet it is an election year, the one period when people can ask these questions and have a right to expect answers.